Originally published by OpenMarkets
I recently wrote a piece on warrants from the position of knowing very little (or next to nothing) about warrants. The things I know about MINIs relate more to the British car of the same name, so once again I am educating myself to educate you.
Two interesting facts I unearthed – firstly, MINI warrants share more similarities with Contracts for Difference (CFDs) than warrants, and secondly, the Administrative Appeals Tribunal (AAT) ruled earlier this year that MINI warrants are not derivatives under the Corporations Act 2001 (Cth) and therefore not financial products – a decision that ASIC has appealed. Intrigued? Read on.
What are MINIs?
MINI warrants (hereafter referred to as MINIs) can be classified in two broad categories – trading MINIs and instalment MINIs. Each has distinctive characteristics, so I will examine them separately. Each is listed on ASX and more recently, Chi-X.
Trading MINIs offer leveraged exposure to an underlying asset; such assets include shares, indices (local and international), ETFs, currencies and commodities. The MINI enables the investor to track the value of an underlying asset, on a one for one basis, for a relatively modest upfront cost.
There are three types of trading MINIs:
MINI longs – enable investors to benefit from an upward price movement in the underlying asset
MINI shorts – enable investors to benefit from a downward price movement in the underlying asset or hedge an existing position against a fall in its value
Guaranteed Stop Loss (GSL) MINIs – enable investors to ‘risk manage’ exposure, as have the added benefit of a guaranteed stop loss level. GSLs are only available over ASX-listed stocks and domestic indices.
There’s one other type of MINI which I am not going to focus on in this blog, however it warrants a mention (no pun intended):
Instalment MINIs – this class of MINI is quite different to trading MINIs – it enables investors to access medium to long term exposure to the stock market, enhanced dividend yields and franking credits and gearing without the risk of a margin call. Unlike trading MINIs, instalments MINIs have an expiry date and, at maturity, investors have three options:
- pay the final instalment and receive the underlying securities
- roll into another series of instalment MINIs
- cash out any value remaining in the investment.
Longs and shorts
With MINIs longs or shorts, investors can trade for a fraction of the underlying asset price, without having to own the assets outright. There are two features that make them a popular tool – investors are never be exposed to margining, and the maximum possible loss is no greater than the initial outlay. In other words, you can lose your money, but it stops there.
Features
MINI longs and shorts combine the features and benefits of other warrant types with unique features of their own.
- MINIs offer degrees of leveraged exposure to a range of underlying assets. This range is typically between 50 and 95 percent, and is determined by the difference between the MINI’s exercise price and the price of the underlying asset. One security may have several MINIs issued, offering different degrees of leverage.
- MINIs have an in-built stop loss feature, set above the exercise price for MINI longs and below the exercise price for MINI shorts; this ensures investors cannot lose more than their initial capital outlay.
- Unlike other types of warrants, MINIs are open ended contracts with no set expiry date; as a result, a MINI will generally track the underlying asset on a one for one basis. Interestingly, it is this feature that led the AAT to rule that MINIs are not a derivative and therefore, not a financial product.
- Unlike instalment MINIs and other warrants, trading MINIs cannot be exercised to buy or sell the underlying asset – they are cash settled.
- MINIs allow an investor to make an upfront payment and borrow the balance from the issuer, who then charges interest and borrowing fees. If a MINI is sold the day of purchase, no interest is charged.
- The amount paid to buy a MINI is generally the difference between the price of the relevant share and the current exercise price of the MINI.
- MINI issuers are generally market makers, which ensures there is always a buyer when investors wish to sell a MINI.
See our interview with Elizabeth Tian, Direct of Equity Products at Citi, on how MINIs work:
Pros and cons
As with any investment, there is the good, the bad and alas, sometimes the ugly. The pros and cons are summarised in table one.
Table one: The pros and cons of longs and shorts
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MINIs versus CFDs
I was intrigued to see certain commonalities between CFDs and trading MINIs. As with CFDs, MINIs mirror price movements in the underlying asset, do not require the investor to pay the full value of the underlying investment, and offer exposure to falling markets.
The significant difference is that the trader of a MINI can lose no more than their initial investment – investors using CFDs can, literally, lose the shirt from their back. The similarities and differences are highlighted in table two.
Table two: MINIs v CFDs
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Are MINIs a derivative?
Quite literally, the jury is out on this one. The intrigue started in December 2015, when ASIC banned an adviser who carried out transactions with MINI warrants two years earlier. ASIC deemed the adviser had breached market misconduct provisions.
The adviser appealed his three-year ban and the AAT upheld the appeal – in their view, as an open-ended contract with no set expiry date, the MINIs in question did not satisfy s761D(1)(b) of the Act or reg 7.1.04 of the Corporations Regulations 2001. In other words, not a derivative, not a financial product – and therefore, the market manipulation provisions of the Act (and market misconduct provisions generally) do not apply to MINIs.
As you can imagine, ASIC is strenuously objecting to this and acting to ensure that MINIs fall within the bounds of the corps law and thereby required to abide by market misconduct provisions.